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A GOOD READ>>>> Signal Lost: Internet telephony—digitally transmitted phone calls—could be the Next Big Thing. It's cheaper than the conventional system, and that makes the technology compelling.


By Rana Foroohar
Newsweek International
Jan. 24 issue - Jeff Pulver used to spend long hours in his basement hunched over his ham radio. The hobby was fun, but geeky. So Pulver did what many other teenagers in 1970s suburban New York did: he bought a Trans Am sports car. Then he figured out a way to use the ham- radio equipment to rig up a makeshift car phone. "I thought it would impress girls," he says. It didn't. But the invention may have prepared Pulver for a more significant epiphany, which came to him in 1995.

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By then Pulver was a computer-systems administrator on Wall Street. He was home sick one day and surfing the Web when he came across a computer program designed to transmit voice over the Internet, offered free by the Israeli firm VocalTec. Pulver downloaded the software and donned his headset. Soon he was speaking with many of his old buddies from his ham-radio days, who had also caught on to voice software. They had even transferred their ham-radio monikers to the Internet. The voice quality was poor and the software cumbersome, but Pulver was hooked.

From that day it was clear, at least to Pulver, that this simple program represented more than a way to reconnect with fellow geeks without having to pay long-distance telephone charges. The software presaged a fundamental change in the technology of telephone calls, something which could ultimately have as big an effect on telephones as the PC did on computers.

The idea was breathtakingly simple: when it comes to the Internet, voice is just another form of data. Once you accept that premise, suddenly the vast networks of telephone wires and switches dedicated to carrying phone calls seem redundant. Instead, why not just take our conversations, turn them into little bundles of digital data, and send them out over the Internet? Each packet would, like e-mail, wend its way from server to server until it arrived on the other side of cyberspace at its destination—which could be a telephone (but one that could plug into the Internet) or a computer. Pulver wasted little time. He left his job and started proselytizing full time.

In the years since, converts to what's technically known as voice over Internet protocol, or VoIP, have been growing quickly. Vonage, a company that Pulver helped start, has been one of the big winners. It is now the top provider of Internet phone calls in the United States, with more than 400,000 customers paying as little as $24.95 a month for unlimited calls. Corporations have taken to using the Internet to make phone calls, saving themselves a bundle on long-distance charges. A recent AT&T survey showed 43 percent of multinationals either using, testing or planning to switch to VoIP within two years. The telephone companies, initially dismissive of Internet telephony as unreliable and poor in quality, have recently begun integrating the technology in their own operations. Virtually every major phone company—Verizon, AT&T, Deutsche Telecom, NTT and many others—are upgrading their networks to handle Internet calls. British Telecom announced plans last year to invest $20 billion. As Cathy Martine, senior VP of AT&T says: "It's not a question of if this will become the new standard for voice transmission, but when."

What entrepreneurs like Pulver have long known, and telephone-company executives are beginning to realize, is that Internet calling is a classic disruptive technology—a simple idea that fundamentally changes the premise of an entire industry. Ever since Alexander Graham Bell first turned sound waves into electrical signals and sent them down a wire, the notion of a dedicated telephone circuit for each voice call has been the telephone industry's chief paradigm. Internet voice technology is the biggest threat to their businesses in a century. If voice is data and telephone networks are redundant, who needs telephone companies? Or to put it another way, what's to prevent anybody at all from going into the telephone business? "When all you need is a Web site and a brand to sell telephone services, what's to stop Microsoft, or even Wal-Mart, from providing your calls?" asks Frost & Sullivan telecoms analyst Jon Arnold. Indeed, the revolution is already happening. Time Warner and Yahoo have gotten into Internet-phone services. And last week Comcast, the U.S. cable-TV firm, launched a service that it will market to 15 million of its customers this year.

The impact may be felt far beyond telephones. Internet voice technology could bring about the much-heralded—and long-awaited—convergence of digital media. With telephone companies adopting Internet protocols, the union of phones with televisions, computers and any other digital doohickey will become easier. The race among firms like Samsung, Sony and Apple to invent the next top-selling gadget could soon get chaotic. Analysts are already speculating about the bizarre merger-and-acquisition possibilities—imagine Microsoft, Sony or Nokia buying a telephone company.

The beginnings of Internet voice technology go back to 1984, when the United States began deregulating its telecommunications market. Many countries in Europe and elsewhere soon followed suit. For the next decade, dozens of major telecom companies in newly competitive markets fell over themselves to lay down billions of dollars worth of fiber-optic cable in an effort to stake out market share. Ironically, the telephone companies were early in using Internet-like technologies to send voice calls—digitized and bundled together—over these big transmission cables. But they never went so far as to use Internet protocols—the Internet's basic technology—to transmit voice data. They preferred to keep the data within their own closed networks.

Even as big players like Level 3, AT&T and Global Crossing were laying their fiber, the grass-roots Internet-call movement was growing unseen. In 1995, Pulver formed his first company, Free World Dialup, which distributed free software to make Internet calls, and began running conferences for the growing community of people drawn to the idea of sending voice over the Internet. In 1996, the movement attracted the ire of U.S. telephone firms, which petitioned the U.S. Federal Communications Commission to bar the small firms from offering Internet telephone service. Pulver became a folk hero of sorts by leading a group of technology firms to defeat the lobbying effort.

With that battle lost, the phone companies might have taken the opportunity to embrace the new technology, cutting costs and adjusting their business models accordingly. Still, it was tough to tell at that point just how big Internet telephony would be—quality was poor, the technology primitive and the number of broadband connections to homes low. So instead, the telecom industry latched onto another phenomenon: mobile phones. With mobile revenues soaring, telephone companies bet that cell phones were going to drive the technology in their industry for the next few decades. So-called 3G, or third-generation, technology was supposed to usher in a new era of wireless broadband in which people would get information and entertainment through their mobile phones. The big telecoms invested billions in 3G, spurred on by state auctions of frequencies.

In hindsight, cell phones now don't seem all that revolutionary after all, at least compared with VoIP. Like old-fashioned telephones, mobiles are a "walled garden" business, in which the telephone companies use their own networks and retain control over all aspects of the voice data. "Once 3G was on a roll, the telcos didn't want to move to IP standards," says Westhall Capital analyst Cyrus Mewawalla. "Everyone wanted a closed system. They felt it was the only way to protect their revenue stream." The telcos didn't foresee that one day wireless-data technologies Wi-Fi and Wi-Max would give mobile callers close to wireless hotspots an opportunity to circumvent the phone networks. Back in 2000, when dozens of VoIP companies went belly up during the dot-com crash, the technology didn't seem like a big threat.

But the next year, as BT and other big telecoms struggled with $250 billion in 3G debt, prospects for Internet calling began to change. For starters, a good portion of homes now had broadband connections to the Web. The quality and reliability of VoIP calls had also improved, and adapters that allowed customers to use phones rather than computers to make VoIP calls also became widely available.

Pulver, who was still running Free World Dialup and holding conferences, connected with serial entrepreneur Jeffrey Citron, who had already founded Island ECN, a computerized trading firm, and Datek, an Internet brokerage. Citron became CEO of Vonage. Pulver, who sat on the board for a year, is now a minority shareholder. But he's the fledgling industry's biggest evangelist, with several other small VoIP start-ups and a much-read blog (pulver.com).

Citron and Pulver are by no means the only entrepreneurs to ride the VoIP wave. Skype, a Tallinn- and London-based firm founded by Janus Friis and Niklas Zennstrom, the brains behind the notorious Kazaa music file-sharing software, claims to have 21 million users. Unlike Vonage, which charges a flat rate, Skype distributes free file-sharing software that enables users who are both on the system to talk to each other free of charge. Skype has yet to generate any profits, but is already charging for calls to non-Skype users, and plans to charge for things like downloadable ringtones, customized call waiting and other services. Although Europe is its biggest market, the company also has a partnership with Daum, South Korea's largest Internet portal. Says Zennstrom: "We want to do for telecommunications what companies like Ryanair have done in travel—change the rules of the game."

The plan seems to be working. The runaway success of VoIP services depends on the proliferation of broadband connections to people's homes. In South Korea and Japan, where more than two thirds of the population have broadband access, VoIP is growing like wildfire. In Korea, there's a special prefix—070—for VoIP phone numbers. In Japan, 10 percent of households use Internet telephony, and a VoIP service offered by Softbank boasts 4.4 million subscribers. Its growth has depressed revenues of the local telco, NTT, and has prompted it to start its own Web-calling service. In November, NTT announced a plan to migrate 30 million customers to high-speed Internet-based networks by 2010.

In Europe as well, in the wake of the 3G disaster, phone companies have begun to look at voice over Internet with fresh eyes. BT's $20 billion initiative seemed to surprise even its own executives. "Nobody expected the large, slow-to-change, traditional and conservative" company to announce such ambitious plans, says Paul Reynolds, a BT executive. BT isn't alone. Nearly every major telco in Europe has begun upgrading its networks. Plenty of nontraditional companies are getting into the game, too. The Italian newspaper La Repubblica offers a VoIP service to drive traffic on its Web site. The U.S. retailer Best Buy is partnering with AT&T to sell its VoIP plan, and even Wal-Mart has begun offering VoIP phones on its e-commerce site—analysts are already speculating about when the giant will take the next step and offer a full-blown service.

The most tangible benefit to this shakeup of the $1 trillion global telephone industry is a radical reduction in the cost of a phone call. But there's a limit to how much money can be made from cheaper phone calls. For this reason, many experts expect companies to bundle different media, devices and technology platforms together in search of profits. VoIP allows cable companies and Internet service providers to get into the telephone business. And it may also embolden telephone companies to enter other data services, such as television (sidebar), video on demand or streaming audio, or to rent their lines to more creative companies that will. BT executives, for instance, envision football matches with live video chats, and remote classes in which students see and talk to each other via computers, TVs or PDAs. NTT has similar designs. "We want to become a one-stop, ubiquitous service that links a video-capable fiber-optic network and a mobile-phone network, that can be accessed via computer, TV, mobile phone or a networked appliance," said NTT's CEO Norio Wada in November.

VoIP has already severed the link between a geographic location and a phone number—someone in Mumbai can now purchase a number with a Manhattan area code, and carry it with him wherever he goes. Road warriors can count on local, rather than long-distance, dialing rates by using VoIP products from their laptops. Some services allow you to pick one number that will ring through to as many as six locations in order to find you. Instant messages can automatically be turned into phone calls, and vice versa.

Personalized features that would allow you to choose one answering message for your mother and another for your boss will become standard. But beyond this is an even more exciting world of convergence: for teens, always-connected mobiles would allow them to chat with their friends continually, just as if they were in the room. Families could hold Sunday teleconferences via televisions that double as phones. Singles bars might have matchmaking computer data-bases that automatically place a call to a potential sweetheart. Phone calls could be made from just about any device—an iPod, a laptop or a refrigerator.

The big losers may very well be yesterday's darlings: the mobile-phone companies—especially those who invested heavily in 3G, such as Vodaphone. Indeed, the tide seems to be turning away from 3G, at least for the moment: European rollouts have been a disappointment; Chinese government officials have delayed their 3G auctions several times and are now asking Intel to build Wi-Max networks in major cities; Motorola, HP, Sony and Nintendo have begun putting Wi-Fi chips in their latest gadgets. Perhaps because it doesn't have its own mobile division, BT has been the most aggressive of the global telecoms in offering Wi-Fi cell phones that allow customers to make VoIP calls at hotspots. Such services could cut 70 percent off mobile-phone-company revenues by 2007, says a report by Westhall Capital.

And who will be the big winners? Nobody really knows. Internet voice technology is about to crack open the entire industry. In the United States, the big cable companies may take the majority of the pie because they have the fastest data pipes, the most broadband connections to the home and fewer regulatory issues than the telephone companies. Already Cablevision and Time Warner are nipping at Vonage's heels. Owning the wires still carries an advantage, especially for customers concerned with top quality and security.

And what about the "disruptors"—Skype, Vonage and the countless no-name VoIP companies that started the revolution? They may face some tough times. Most experts believe that many of the smaller firms will eventually go bust or get gobbled up by the incumbents. The big phone and cable companies are not likely to go out of business any time soon, which gives them an edge with corporate customers. And, since cheap phone calls will likely become a hook for selling digital content and services, cable and media companies already in those businesses will probably have a leg up. Firms that have a deep understanding of the digital lifestyle, like Microsoft or Apple, or consumer behavior, like Wal-Mart, could hold the trump cards. One thing's for sure. The age of the telephone, as we know it, is over.

With Kay Itoi in Tokyo and B. J. Lee in Seoul

© 2005 Newsweek, Inc.





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